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By Michael Turner, Ph.D. May 27, 2010 Policy & Economic Research Council Evaluating the Inclusion of Utility Payment Data in Credit Reports Credit Scoring and the Unscored…

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2 Utility Reporting: Solution to the Problem of Credit Access 30 Million Americans with no payment histories (PERC)  No credit score possible; little access to low priced mainstream credit 75 Million with two or fewer payment histories (PERC)  Too few tradelines = reduced credit score, if scoreable; pay more than should for credit 120 Million with credit scores <740 may have their score increased with a more complete file of their tradelines (Michael Nathans, Sr. Fellow--PERC)  Are denied or pay more for credit, insurance, employment: could benefit from having more existing accounts reported 2

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3 What is Credit? Who is a Creditor? 3

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4 What is Credit? Who is a Creditor? The term "credit" means the right granted by a creditor to a debtor to defer payment of debt or to incur debts and defer its payment or to purchase property or services and defer payment therefor. The Equal Opportunity Credit Act (ECOA) and the Fair Credit Reporting Act (FCRA) define credit and creditor as: The term "creditor" means any person who regularly extends, renews, or continues credit;

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5 What is Credit? Who is a Creditor? Utilities are creditors Utility payments are credit payments Clearly, utilities can report payments to CRAs (and some utilities do)

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6 Q:Are Utility Payments Used in Lending? A: Utility payments are used in lending It is non-controversial and advisable to use a complete picture of a borrower’s obligations and payment history when underwriting and assessing capacity and risk. A: Use of utility payments is common in alternative scores and undewriting Fannie Mae Freddie Mac FHA Genworth (mortgage insurers)

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7 To report or not to report… That is the question How do consumer’s fare if utility and telecom information are included in credit file? What is the benchmark? What are we comparing?

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Relevant Caveats and Misconceptions About Reporting? Metro 2 is a flexible reporting format: Not limited to 30-, , 180+ day “buckets” Provides furnisher choice (within parameters) on how to report o Needn’t report defaults below a certain dollar value; and o needn’t report special status of individuals on deferred payment plans or LIHEAP recipients. FICOs reporting system weighs mild negatives mildly and only serious negatives seriously: Score effects on 30 and 60 day delinquencies are generally mild and recovered from within a moderate timeframe (recency matters) 90 day delinquencies are effective predictors or default/ measures of whether one can afford a loan 8

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To Report or Not to Report… A: NCLC shows that 85% of lowest income quintile paid their utility bills on time in 1998 Cannot, therefore, talk about “Low- Income” consumers monolithically. Q: Are Low-income Consumers Hurt When Their Utility Payments Are Fully Reported? 9

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Q: But…. would scores fall much for that 15% that paid late? A: That depends on many factors: How late were they? Did they have utility collections reported? How “thick” is their credit file? Were they late on other payments reported? Are Low-income Consumers Hurt When Their Utility Payments Are Fully Reported? 10

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The best way to determine the impact on low-income consumers is not via speculation but empirical testing with: Real low-income consumers Real credit files Real credit scores Then compare outcomes when utility payment data is and is not fully reported. ….we did just that. Are Low-income Consumers Hurt When Their Utility Payments Are Fully Reported? 11

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Original Finding: Little Effect on Scores Change in Credit Score with the Addition of Utility Payment Data (March 2005 – March 2006) 66% scores had little or no change in scoreKey metric: 13

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Key Findings: Increased Access for Underprivileged Social Segments Change in Acceptance Rates at 3% Delinquency Target by Race/EthnicityIncome 20%+ of African American and Latino segments able to now get mainstream credit Key metric: 25%+ of households earning < $20K able to now get mainstream credit Key metric: 14

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17 Source: Experian 2010 Case Study #1: VantageScore® Changes (all customers) 17 “Many consumers have thin or no credit files, making them unscoreable.” Center for Financial Services Innovation Total consumers 5% to 6% of the consumers became scoreable with the additional utility trade 4% of the portfolios were new consumers

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Case Study #1 Scoreband changes (all customers) 18 Source: Experian 2010 Key findings ► Over 91% either stay within the same band or move to a higher band ► 84% of the scores that declined were already in a negative scoreband Consumers Very little change due to the addition of a utility trade 18

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Summary of Effects How do we compare impact of non-reporting to impact of reporting?  Number of people positively affected--points to reporting  Number of people negatively affected--points to reporting  Accuracy of score--points to reporting  Minimizing harms—points to reporting 21

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What is “Harm”? The objective of credit reporting is…  An accurate assessment of risk, meaning, associated harms Low-risk borrowers are not mistaken for high-risk ones High-risk borrowers are not mistaken for low-risk ones Denial of credit to those who can afford it (leaving high priced credit options) Provision of credit to those who cannot afford it (overindebtedness) Effective underwriting = reduction of harm 22

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What Does it Mean to Say That a Score “Harms” You? What is a credit score?  A prediction based on a set of credit and other transaction behavioral factors Credit history Indebtedness levels Payment behavior Etc.  Harm--two conceptions of how a score can harm you? Lower score vs. a score that does reflects risk poorly Is a lower score a harm if it more accurately reflects your risk than a higher score? 23

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Given “Harm”, What are the Choices Before US? Return to two “thin-file” scenario results  Scenario 1: we exclude utility data 13% of consumer will have increased scores 7% of consumers will have scores unchanged 20% of consumer will have decreased scores 60% of consumers will have NO score  Scenario 2: we include utility data 20% of consumer will have increased increased 7% of consumers will have scores unchanged 13% of consumer will have decreased scores 60% of consumers will have scores With reporting, more people have increasing scores and fewer people have decreasing scores…because the vast majority of people, including lower income segments, pay bills on time 24

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Given “Harm”, By What Standard Can We Evaluate Choice? Credit scores make accurate assessments of risk, so; Better scores are more accurate scores This means that utility payment data is a good predictor of the consumer’s risk 25

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Score or No Score? Q: Is it better to have a moderate or low score or no score? A: No score consumers are treated as highest risk; Low and moderate scores allow entry into mainstream markets Most thin-file, no file segments have moderate to high scores.  Score distribution similar to that of thick file population, excluding “super primes” (which require thicker credit histories)  No evidence that access leads to overindebtedness, above what is witnessed with thick file segments 26

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Key Findings Changes in Score for Consumers with Alternative Data Over a 1-year Period, by Number of Trade Lines (from March 2005 to March 2006) Scores increased for consumers by a larger degree than they decreased over the year-long period 27

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28 Key Findings This means that including alternative data can actually allow more people to enter the credit mainstream

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I actually didn’t even have a credit score for a number of years, I guess because, once again, I didn’t buy a lot on credit. I like to say you have to play the game. I don’t think they have records that show that you paid good cash. Testimonial: Rose Marie and Grandville “ ” 29

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Research Canards I Generalizations  E.g., “lower income people will have lower credit scores” if utility data is included, when…  More low income consumer see score increases with inclusion than score decreases Beware of contextless facts that affect inferences  “collections are increasing, therefore there are more people with delinquencies so more people will have lower credit scores,” when…  Collections will be reported no matter what.  Scores are dynamic odds ratios. oThe odds of being 90+ days late or more today are quadruple of four years ago. oLate payments are more heavily discounted during economics down times 30 Beware of:

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Unsubstantiated assertions — ask whether a statement has empirical support.  Utility rates vary across states, and therefore, credit scores are determined by geography. But,  Wage, income, taxes, housing, rent, food, and many other variables vary across regions  Should we not report mortgage or credit card payments because of price and interest rate differences by geography? Kitchen sink approaches.  Where multiple arguments are offered each with thin or no evidence  Lots of weak arguments do not make a strong one 31 Research Canards II Beware of: